Economic Logic, Too

About Me

I discuss recent research in Economics and various events from an economic perspective, as the name of the blog indicates. I plan on adding posts approximately every workday, with some exceptions, for example when I travel.

Thursday, November 20, 2008

A lot of governments are now expecting to face severe revenue shortfalls, especially for US states. They should have had some rainy day funds, but the conventional wisdom is that they find it very difficult to build up in good times, because of both the pressure from the electorate to reduce taxes and the temptation to extract political rents beyond lower taxes. These problems led to many states to impose limited borrowing rules on themselves, but it still seems that rainy day funds are vastly insufficient, just look at the current emergency slashing of public spending left and right.

Ricardo Caballero and Pierre Yared argue that this should not be so in an economy with substantial fluctuations, where a rent-seeking government over-saves compared to a benevolent government. The idea is that if economic uncertainty is more important than political uncertainty, politicians over-save in order to make sure to get reelected and exploit rents in the future. For example, if the economy is low, the government keeps taxes low to guarantee reelection, in the anticipation that when the economy is better, the taxes will be increased and more rents can be extracted. This will also prevent future politicians to extract anything significant.

How can one then force the government to act more benevolently? Cap deficits again, but for different reasons than usually, as politicians tend to behave the opposite way of other situations. They still want to run deficits, just at different times. This contrasts, however, with my earlier post showing that soft budget constraints may be optimal. the case then was that there could be substantial moral hazard in completing investment projects if spending needs to be curtailed.

Wednesday, November 19, 2008

Arranged marriages are alive and well, and the Internet allows apparently even this institution to flourish. Witness Marry our Daughter where underage daughter are proposed for marriage. This site features bride prices based on biblical justifications. But there can also be perfectly rational, economic justifications for a bride price.

The bride price is based on the idea that a family looses child-bearing services when it gives a daughter away. The argument is very similar to the one used to justify the high pay of prostitutes, especially young ones.

In this context, it may be puzzling that one can also have dowry, that is, a gift that a woman brings into marriage, typically from her parents. The usual justification is that she will not be able to use the services of her old family, in particular bequests (Maristella Botticini and Aloysius Siow). One can therefore understand dowry as an anticipated bequest. In fact, bride price and dowry can coexist, see Ted Bergstrom.

Tuesday, November 18, 2008

High school seniors in the United States are now sending their applications to universities and they will soon face the problem of choosing between public and private colleges. This year seems to be different from others, as student loans were apparently among the first ones to suffer from the current financial crisis, despite being in many cases guaranteed by the government.

As private universities have typically suffered heavy losses in their endowments and are thus not expected to offer the level of tuition support of past years, students are expected to be more likely to accept offers from public universities. In fact, the latter already report much larger admission submissions than previous years.

At the undergraduate level, there is not much difference between public and private universities in terms of value added. Having taught in both, the variance of students is high in both, and I saw no notable difference in motivation. Teachers are better in elite universities, whether private or public, as teaching and research qualities are positively correlated.

Is it worth going private if one did not get into a public school? I would say no. Lower ranked private universities are not worth the price and the student debt. If a student could not make it to public university, he should not go to college at all, as I have argued before.

The quality of students in public schools may actually significantly increase for next year "thanks" to this crisis. And universities may want to accomodate this with increased enrollments. It would not be a good time for state governments to cut support to their universities.

Monday, November 17, 2008

While I argued a few days ago that war was good in Malthusian economies, there is little doubt that war is bad in modern economies, except possibly for winners. Thus on average wars generate welfare losses. Then why do we still have wars? One key aspect here is that wars could be instigated by leaders who disrespect the welfare of their underlings. The logic conclusion of this argument is that democracies should be much less at war as, following Kant, democracies need to be accountable.

Paola Conconi, Nicolas Sahuguet and Maurizio Zanardi test this hypothesis by exploiting the fact that in some democracies presidents face term limits and are thus not accountable in the last term. The idea is that there is a repeated prisoner's dilemma game, where the horizon of the policy maker does not necessarily coincide with the country. Policy makers are semi-benevolent, care about rents from reelection and election success is endogenous. There is a short-term electoral boost of war, following Gregory Hess and Athanasios Orphanides, but there is more importantly a long-term cost to the country.

Conconi, Sahuguet and Zanardi construct a dataset of term limits from 1816-2001 for many countries and find that presidents in a legally binding last term behave as aggressively as autocrats. Thus, democracy is not sufficient to bring peace, you need to avoid term limits as well. However, what to think of the electorate, as voting for a lame duck seems to have negative consequences? Are people stupid, or are they manipulated? Also, the paper does not explore the implications a lame duck to continue presiding through his party (exhibit A: Vladimir Putin). But even without these consideration, the empirical evidence should us to explore ways to make war more difficult for lame ducks, as they have war mongering inclinations.

Friday, November 14, 2008

Today, David Cass is celebrated at the University of Pennsylvania. He was not only a supreme theorist, but also a driving force in the department, both with graduate students and with CARESS, a research center he founded to help researchers disseminate their work.

His work on general equilibrium theory is probably the best known. For example, he modified the Ramsey model to take into account discounting, and the model is nowadays often refered to as the Ramsey-Cass-Koopmans model. David Cass has also developed crucial analysis of the overlapping generations model and sunspot equilibria. He also advised numerous graduate students.

For people outside these circles, he will however be best remembered for his fight against the UPenn administration that tried to remove him from administrative responsibilities because he happened to be in a relationship with a (willing) graduate student. In reaction, he gave a memorable speech on women (pdf) that is a very good showcase of this free thinker.

Thursday, November 13, 2008

While is it apparently known that wearing red apparel improves performance in sports (and this has nothing to do with the earlier post on red-shirting), what about the colors of national flags and the World Bank's Human Development Index (HDI)? Voxi Heinrich Amavilah tackles this all important issue.

And the result is that flag colors do not really matter. While one may have some serious doubts at the theorizing in this paper, it is reassuring that the empirics turn out the expected result. An example of what counts as theory here: the dominant colors of a flag are reduced to a number by the sum of numbers arbitrarily assigned to base colors. To quote the paper, "Afghani dominant flag colors are Black and Green set on White. Therefore, the dummy variable for the Afghani flag colors = White + Green + Black = White + (Yellow x Blue) + Black = 5 + 8 + 1 = 5 + (2 x 4) + 1 = 13." And so on. One can only hope no journal will accept such work.

Meanwhile, I take from this exercise that we can continue to stick to the fundamentals of the economy.

Wednesday, November 12, 2008

Getting the right people married to each other is a very complex undertaking. Preferences are heterogeneous and information issues are important in marriage markets. Economists have been interested in finding ways to get Pareto equilibria in such markets, algorithms that can also be applied in other matching markets, says for medical school seats, medical residents, electricity markets and so on. The standard approach is the Gale and Shapley algorithm, wherein everybody ranks his/her best mate, and successive rounds of matches from the top down allow a Pareto optimum.

This algorithm has been challenged on various grounds, in particular because it does not deal with envy. One could imagine that introducing side payments may introduce fairness: if you lucked out on a potential mate, you are compensated by the lucky one. However, Bettina Klaus offers an explanation why side payments are not sufficient to gain fairness. The big stumbling block in the indivisibility of the matched objects. In other words, one cannot randomize or diversify.

Tuesday, November 11, 2008

Today, many countries celebrate the armistice, contemplating the contributions of their veterans and the losses and gains imposed by war. I want to reflect here on how internal wars may have contributed to the rise of Europe over the past millenum.

I have already reported how the steady competition among European powers forced them to keep taxes low and guarantee property rights in order to prevent emigration and how this helped Europe to grow faster than the Asian hegemonic empires. Nico Voigtländer and Joachim Voth have a different angle on this point. They claim that the competition among European states lead to sufficiently many wars to keep population from growing. In a Malthusian economy this is a particularly important point: With lower population and decreasing returns to labor, people are living above subsistence levels, which means longer lives, added incentives to save, and the ability to think beyond subsistence and innovate.

In those days, wars were horrible as they are today, but they may have left the foundations of today's wealth. Who knew then?

Monday, November 10, 2008

It is well known that tall people have more success on the labor market, see for example T. Paul Schultz. The big question is whether this is due to discimination, say, because tall people are considered more beautiful, or because being tall is a signal of other positive characteristics. Schultz, for example, has highlighted that being tall is a sign of health.

The articles of Anne Case and Christina Paxson in the Journal of Political Economy and the American Economic Review detail how tall people have actually more cognitive abilities. It is not because the air is better higher up, it has to do, they demonstrate, with the fact that children that are taller at age 3, before school had any influence, already show better cognitive skills. Jere Behrman and Mark Rosenzweig also demonstrated that higher birth weights lead to better school attainment. This just reinforces the point that James Heckman has been pushing so hard, that schooling and labor market outcomes are to a large extend determined even before children are going to school.

In economies where nutrition is more important for developmental issues, Carl-Johan Dalgaard and Holger Strulik show with an intriguing biologically micro-founded model that tall people have distinct labor market advantages: They have higher wages and are less unemployed. It is, however, not clear whether this can translate to an economy with little food security issues.

What prompted me to write about this? Reading about tall people being upset at so-called discrimination in some airlines. Indeed, some of the latter are charging a fee for the priviledge of sitting in the front row or on an exit row where the legroom is larger. Tall people view this as a tax against them. In fact, one should tax them, as shown by Tomer Blumkin, Yoram Margalioth and Efraim Sadka, and as such tax does not exist, they should count themselves lucky. And by the way, if tall people need those seats so badly, why would they not pay for them? And if they are more expensive, they are less likely to be taken by short people.

Friday, November 7, 2008

Chatting and cheap talk in the office may have a impact of the social cohesion of the group, but does it matter amongst strangers? Stefano Demichelis and Jorgen Weibull take the example of the following game popularized by Aumann:

c

d

c

9,9

0,8

d

8,0

7,7

This is reminiscent of the prisoner's dilemma. If players can coordinate, c,c is the optimal outcome.But as both have the incentive to deviate, d,d is the Nash equilibrium. In other words, both say c but secretly think d. However, if they can send some message that has some meaning c,c can become a stable equilibrium.

This is different from a repeated game. There, if the same players keep interacting, they can build a reputation and c,c becomes, as experimental evidence shows, easily the equilibrium. The Demichelis and Weibull paper shows that small costs of lying can destabilize the d,d equilibrium as well. This may seem trivial, as adding such costs is equivalent to reducing the outcomes of strategy d. In the present context, however, the point is that pre-game messages ("cheap talk") are partof the information set of actions. These messages may be complex, such as detailing what action one player takes in response to the other. But this cheap talk, even if cheap, may be effective in getting the better, cooperative outcome.

Thursday, November 6, 2008

Some economists like studying their hobby, witness the large number of papers written on Sports Economics, and there are some quirky associations out there. Exhibit one, the American Association of Wine-Economists, where wine tastings are surely part of the agenda and studying the Economics of wine is a good excuse.

Tuesday, November 4, 2008

For a market to be efficient, it needs to be clear what the prices of the goods are. As I am traveling, I am noticing that who prices are advertised differs notably from country to country, and I wonder what this implies for efficiency.

Take for example sales tax or VAT, depending on country. In some places, such a tax is included in the price, while in others, it only gets revealed once the transaction is concluded. It hurts the transparency of the price. We all know the example of airline tickets, where all sorts of surcharges and taxes can in some cases multiply the price. I am especially irked by this "fuel surcharge," where the ticket price could easily reflect it. In the case of hotel reservations, guests often do not know the final price until check-out. For the sale tax, it is usually guessable what the final price is, but it is annoying, and it never ends up with a round number thus needing extra change.

Why would sellers not state the real final price? Because it gives the impression it is cheaper and the potential buyer does not have the guts to cancel the transaction after realizing what the true price is? Because it makes people more aware what share of the price is attributable to taxes? (I once saw a receipt in Canada attributing the federal and provincial sales taxes to the respective prime-ministers who introduced them). Because the first mover in including taxes would face a disadvantage with respect to the competition?

Clearly, we are a situation with a Pareto dominated equilibrium. This calls for government intervention, imposing on retailers to include taxes, charges and fees in their price.

Monday, November 3, 2008

Jacques Piccard, the second generation in an ongoing line of explorers died on November 1, 2008. Trained as an economist, he joined his father's operations and dived in 1960 11,000 meters (seven miles) into the ocean. This record still holds and cannot be beaten, as this was the deepest place on earth. Surprisingly, he and his diving partner found life at such depths in the forms of shrimp and fish.

In 1969, he dove with seven partners in the Gulf of Mexico and let his capsule drift with the currents to reemerge four weeks later on the coast of Maine. His father Auguste was remarkable as well, as he was the first man reaching the stratosphere, and thus technically the first man in space, using a balloon. Auguste was the inspiration for Captain Jean-Luc Picard of Star Trek and Professor Calculus in the Tintin comics. Jacques' son, Bertrand, was the first man to circumnavigate the earth in a balloon without stopping and is currently working on achieving the same with a solar powered airplane.